Market report End September 2008
Focus on the problems arising from pricing illiquid assets at market distressed prices
a) September was a month that all investors would like to forget. Unfortunately the start of October was even worse. Last month stock prices experienced one of the weakest months in history. The major stock averages in USA and Europe last month suffered about 9% while the dollar appreciated and commodities fearing recession sold off. About 20 trillion $ in world stock market capitalization (about 30%) have now been lost in a year.
b) Amazing! The legendary firms Bear Stearns, Lehman Brothers are now gone. Merrill Lynch was sold at fire price to be saved. Morgan Stanley, Goldman Sachs were barely saved becoming commercial banks. Financial Giants AIG , Fannie Mae and Freddie Mac needed government rescue. Fortis, HVB,Northern Bradford Bingley were nationalised or needed bailouts and we witness runs and rumors on the financial health of Banks.
c) To remedy the situation, a huge $ 700 billion Financial Rescue Plan was finally accepted by Congress. In Europe, various bailout efforts are undertaken. Coordinated interest rate reductions of 0.5% by Central Banks were effected and a purchase plan of commercial paper by the US Government will be undertaken.
d) Investors run for cover from all Asset classes.
Real estate prices, the source of the problem, have dropped worldwide by 10% to 50%. Bonds with A+ rating defaulted or were barely saved. Stocks are selling off. Cash in some Banks is considered unsafe and governments attempt to guarantee and restore confidence.
e) Who is to blame?
Greed and Leverage by small real estate investors, by regional banks, especially by commercial and investment banks that invested excessively in the mortgage market and the drop in real estate prices are to blame. Moreover, we can add to the list insufficient regulation, ‘mark to market accounting’ at distressed prices (what is the price of your house this moment), the aggressive investment philosophy of institutions that are not partnerships but ‘invest other peoples money’ and so on.
f) All markets go up and down but this is the worst negative experience since 1937. The bailout plans, pricing by formulas instead of using market depressed prices and the provision of liquidity attempt to calm the markets and to provide a longer- term horizon, patience and rationality. If mortgage backed assets are marked at distressed market prices they create solvency problems. As a result, the liquidity of the financial system based on repos of illiquid assets disappeared. The Governments attempt to provide liquidity (interest rates reductions, bailout plans, purchases of commercial paper) and patience in order to allow rationality to return.
g) We are probably in the mid of a recession but how deep will it be? On the one hand, rebound from oversold levels, low valuations and the prospect of elections could fuel a rally. On the other hand, negative earnings surprises and more bank failures could lead to lower prices.
h) What shall we do?
Nervous people change their portfolio allocation to gain sleep. Some well known financial and academic gurus recommend to do nothing or even to follow the sport news instead of the financial news. Legendary investor W. Buffet recommends to control ourselves and ‘be greedy when others are fearful and fearful when others are greedy’.
e) Our view is to focus on the long run. In investments, it is more constructive to have problems with shortsight rather than with myopia (by the way I have both problems!).
f) If an investor thinks that the financial system will totally collapse, there will be no safe assets and he/she should start looking for a safe cave and food cans!
Best of Luck to all of us! N.Ritsonis